What Is Private Credit? And Why Investors Are Paying Attention
Private credit has grown rapidly in recent years as an alternative to traditional lending — and investors have taken notice. Learn about this growing asset class and why demand is increasing.
Reliable income is important to investors, but it can be hard to find when real yields are low. Similarly, businesses need a ready source of capital for growth and expansion, but traditional banks just aren’t lending like they used to. That’s opened the door for a different form of lending to fill the void: private credit.
What Is Private Credit?
Private credit refers to privately negotiated loans between a borrower and a non-bank lender. Private credit enables borrowers to access capital with customized financing details they may not be able to secure from traditional lenders like banks. And it’s given investors another avenue to access income-generating investments within the fixed income portion of their portfolio.
These loans may contain a floating interest rate and are often structured with customized terms unique to the borrower and lender. They may also contain terms the borrower must meet, known as covenants, which seek to protect the lender if the borrower defaults.
Much of private credit is direct lending from a borrower and non-bank lender, but there’s various other forms. As private credit has evolved, funding structures have evolved with it, including funding structures like Asset-Based Finance (ABF) where loans are backed by collateral such as hard assets including real estate, machinery, and others.
Figure 1: Asset-Based Finance Ecosystem
A Pulse on the Private Credit Market
While private credit isn’t new, the private credit market has been rapidly growing and attracting investment. Over the last decade, assets in private markets have nearly tripled,1 reaching an estimated $2 trillion, mainly measured by direct lending.2
And growth is expected to continue. Some estimates expect private credit to rise to $2.6 trillion by 2029.3
Figure 2: Borrowers Are Banking on Private Credit
the estimated size of the private credit market as of the end of 2023 4
the private credit market’s growth since the Global Financial Crisis 5
the potential addressable market for private credit 6
Why Borrowers Use Private Credit Instead of Banks
Borrowers seeking funding through private credit may not have easy access to traditional bank lending or the ability to sell corporate bonds. Borrowers that don’t have an extensive credit history or have limited access to bank financing and debt markets, such as startups and small to medium-sized enterprises, can turn to private credit for funding.
Why do borrowers turn to private credit?
Private credit enables borrowers and lenders to structure more tailored deals than is often possible with traditional lending. Lenders and borrowers can work toward customized solutions outside of traditional lending. Borrowers may also acquire loans and financing faster than with traditional lending.
Increased regulations and capital requirements that originated after the Global Financial Crisis, including Dodd-Frank and Basel III, made it harder for banks to extend loans.
With private credit, borrowers can access new capital without diluting ownership.
Private credit can help borrowers access capital in situations that banks may avoid, like distressed debt.
Private credit deals are often subject to less oversight than other types of lending.
Why Invest in Private Credit?
For investors, private credit may provide an opportunity to access higher yields, improve downside protection, and diversify beyond traditional public fixed income.
Benefits of Private Credit Investing versus Traditional Fixed Income
- Higher Yields Than Public Markets. Private credit may offer higher yields than traditional bonds due to an illiquidity premium as well as a complexity premium involved with the securitization/origination process where customized, structured financing is being provided.
- Illiquidity Premium. Investors in private credit may often earn a higher yield than traditional fixed income because the loans are not actively traded on public markets.
- Private Credit Investments Are Usually Floating Rate. Floating rates may help protect investors against interest rate risks and further diversify fixed income portfolios which are heavily allocated to fixed rate exposures.
- Portfolio Diversification. Investors in private credit can broaden their asset allocation beyond public market exposures and gain exposure to unique corporate credit or asset-backed investments with diversified collateral pools.
- Potential Downside Protection. Those private loans that are secured by collateral may help limit downside risks in the event of a default.
Risks of Private Credit Investing versus Traditional Fixed Income
- Credit Risk. Like many traditional fixed income investments, private credit investments are subject to default risk should a borrower fail to meet the terms of their loans.
- Market and Cyclical Risk. Some borrowers may be more negatively impacted by economic cycles which may impact their ability to meet the terms of their loans.
- Less Transparent Than Public Markets. Proper due diligence into loans and investments is needed when lending via private credit, which is often lending to non-public companies.
- Private Credit Is Often Illiquid. While investors earn an illiquidity premium, the trade-off is illiquidity risk and investors may not be able to sell their investments easily.
- Interest Income May Fall If Rates Fall. Given private credit instruments may be issued with a floating rate coupon structure, in periods of consistently falling rates, the income streams from the instrument may decline as the coupon is reset to the prevailing market rate or a pre-set floor within the terms of the loan structure.
- Risk of Regulatory Changes and Added Oversight on Private Credit Deals. While the individual private credit loans face less regulatory oversight than traditional loans given they do not need to comply with traditional regulatory requirements, there still remains potential regulatory scrutiny towards the industry. Changes in lending regulations and/or policies could negatively affect private credit’s growth and origination deal flow.
Types of Private Credit Investments
Different types of private credit investments have varying risk profiles and capital structures. These include, but are not limited to:
Figure 3: Types of Private Credit
| Type of Private Credit | Description |
| Direct Lending | Loans provided by non-bank lenders directly to companies, often mid-sized firms |
| Mezzanine Debt | Debt that sits between senior loans and equity, often including equity, such as warrants |
| Distressed Debt | Buying debt of financially troubled companies, with the potential for restructuring or liquidation recoveries |
| ABF | Loans secured by physical assets such as residential/commercial real estate, aviation equipment, music royalties, machinery, and other assets |
| Real Estate Private Debt | Financing for real estate projects, including bridge loans, construction loans, and mortgage-backed debt |
| Specialty Finance | Lending in niche areas like litigation finance, royalties, aircraft leasing, or trade finance |
| Structured Credit (CLOs, ABS, etc.) | Investments in securitized loans, such as collateralized loan obligations (CLOs) or asset-backed securities (ABS) |
| Infrastructure Debt | Financing for infrastructure projects such as energy and utilities |
Although private investments, many private credit deals are rated by nationally recognized statistical rating organizations (NRSROs) like many public credit securities, despite being privately structured. NRSROs rate private credit by assessing factors like borrower financials, collateral quality, and other factors of the deals. Although private deals, most of private credit’s addressable market is investment grade, in part due to collateral backing and more customizable covenants.7
Compare Public versus Private Credit Investments
Public credit investments generally offer more liquidity than private, but investment options are much more limited. Private credit may offer higher yields, and investing options may be more flexible, but at the expense of liquidity. Here’s how public and private credit are different.
Figure 4: Public versus Private Credit
| Public Credit | Private Credit | |
| Definition | Debt securities traded in public markets | Private loans negotiated between lenders and borrowers |
| Issuer | Governments, corporations (publicly traded) | Private companies, middle-market firms, PE-backed firms |
| Liquidity | Bonds and loans traded publicly, liquidity is usually higher than private | Less liquid than public |
| Pricing Transparency | Public market-driven pricing, updated frequently | Not marked-to-market daily |
| Yields | Yields determined by public markets and interest rates | Often higher yields than public credit due to illiquidity premium |
| Risk Profile | More transparent risk profile | Risk often determined by risk profile of the borrower and the structure of the loan |
| Structure | Standardized terms | Customizable structures, more flexible |
| Regulation | Heavily regulated (SEC, FINRA, Fed oversight) | Less regulated, more flexible terms |
| Interest Rate Risk | Fixed rate public credit securities more subject to interest rate risk | Often floating rate, tied to benchmarks, price movements not as immediate |
| Ease of Access | Easily accessible | More limited access, but growing with vehicles like ETFs |
Who Invests in Private Credit?
Historically, investing in private credit has been limited to accredited investors and institutions:
- Pension funds
- Insurance companies
- Family offices
- Sovereign wealth funds, and
- High-net-worth individuals.
Analysis conducted by the Federal Reserve found the majority of these investors sought out private debt for its potential portfolio diversification, low correlation to public markets, and relatively high returns/yields.8
As the market has grown, calls for the democratization of private markets have grown with it. Product evolutions like private credit ETFs have begun to open up access to this booming asset class for all investors.
How to Invest in Private Credit
There are several ways to access private credit investments for investors looking to add private credit exposure to their portfolios.
Private Credit ETFs
Private credit-focused exchange traded funds (ETFs) can deliver easy, transparent, cost-efficient access to the private credit market in a single trade — making it possible for retail investors to access a market once available only to institutions and ultra-high-net-worth investors.
These ETFs are typically actively managed and deliver exposure to sectors of the private credit market in one of two ways:
- By holding listed instruments that emphasize private credit, like business development companies (BDCs) or CLOs
- By holding private credit directly
Pros: Low barrier to entry, can be bought and sold on secondary exchanges like stocks, potentially lower fees than a private credit fund
Cons: Investment types and yields are limited to what the ETF holds
Private Credit Funds
Private credit funds manage capital from multiple investors and provide loans to private companies. The managers of these funds will often source deals and include a variety of investments across different sectors and industries.
Pros: Active management can help manage risk and will often choose diverse investment exposures
Cons: Typically illiquid and may require high minimum investments
Business Development Companies
BDCs are companies, often publicly traded, that invest in private credit through debt or equity in middle-market companies. Investors can gain exposure to private markets through investing in BDCs.
Pros: Publicly traded and usually liquid
Cons: Subject to market volatility and portfolio performance
Direct Lending
For investors that can lend, direct lending gives them close access to the loans they want to carry in the private credit market.
Pros: High control over investments, direct access
Cons: Limited to accredited investors, requires structuring of deals
Private Credit in the Age of Democratization
Investor desire for added portfolio diversification, the retrenchment of bank lending, and borrower preferences for more customizable loans likely will continue to drive the expansion of the private credit market in the years to come. And democratization — the ability of a new generation of investors to access private credit exposures through tradeable, transparent, and cost-efficient vehicles like ETFs — is likely to propel the growth of this $40 trillion potential addressable market even further.